Nov. 7 (Bloomberg) -- Denmark’s government said it will
seek to intervene in the nation’s mortgage bond auctions to
address refinancing risks after industry steps proved
inadequate.

“Rating agencies and others had questioned the safety of
our model, and we felt we had to act, and that we had to act
now,” Business Minister Henrik Sass Larsen said yesterday in a
phone interview. Industry efforts “didn’t remove the risk
altogether, and that’s what the government now seeks to do.”

The proposal, which has yet to be approved by parliament,
seeks to address a funding mismatch criticized by rating
companies and the central bank. Borrowers and banks in Denmark’s
$530 billion mortgage bond market had grown too reliant on one-year bonds to finance loans as long as 30 years, according to
Standard & Poor’s and Moody’s Investors Service.

The government wants to extend maturities on adjustable-rate bonds in the event the securities can’t be sold or if rates
rise sharply. Though the Association of Danish Mortgage Banks
and the central bank welcomed the step, investors warn they’ll
demand a higher premium to hold a bond with an uncertain
maturity profile.

Investor Concerns

“Some investors may not be able to buy into these bonds
any more as they risk having a short bond converted to a 30-year
bond,” Poul Kobberup, head of fixed-income investments at PFA,
Denmark’s biggest private pension fund, said in an interview.
“Then other investors, like ourselves, won’t accept this for
free, and the conversion option will come with a price tag, but
I don’t know how much yet.” Kobberup manages about $47 billion
in fixed-income assets.

Danish mortgage banks have struggled to wean borrowers off
loans funded by one-year bonds as deadlines near to demonstrate
they can withstand a 12-month funding market freeze. S&P in July
told lenders they risked downgrades if they don’t cut use of the
securities over the next two years. The central bank has also
criticized the bonds and the risks borrowers face if interest
rates rise.

One-year bonds fund about 40 percent of home loans in
Denmark. Borrowers have been attracted to record-low rates
thanks to AAA-rated Denmark’s status as a haven from Europe’s
debt crisis. Still, households have grown more exposed to
interest-rate shocks as debt burdens soar to a world-record of
310 percent of disposable incomes, according to data compiled by
the Organization for Economic Cooperation and Development.

S&P Watching

Under the government’s proposal, short-term bonds would
convert to callable, longer-term securities if refinancing
auctions fail or interest rates climb in auctions by more than 5
percentage points. The new yield would equal the existing coupon
plus 5 percentage points. Existing bonds would be excluded from
the measure, which would go into effect Jan. 1 if approved by
lawmakers.

“This was a game changer,” Jens Peter Soerensen, chief
analyst at Danske Markets, said by phone. “The key thing is
what the rating agencies say. We have saved the one-year loan,
if the rating agencies are positive.”

Per Tornqvist, a Stockholm-based analyst with S&P, said the
rating company is looking closely at the proposal.

“Standard & Poor’s has begun assessing the potential
impact on bank ratings from the proposed changes to Danish bond
legislation,” he said by e-mail. “We may comment on the draft
proposal to revise bond legislation as soon as possible.”

Slim Chance

The measure probably will make it more difficult for
commercial banks to take market share from mortgage banks, which
have raised prices to compensate for the refinancing risks.
Jyske Bank A/S said earlier this month the higher fees had
created an opportunity for the Silkeborg-based lender.

While the business remains “attractive,” Steen Nygaard,
Jyske’s head of treasury, said today by phone, “borrowers may
be less receptive to our product.” Central bank support will
ensure investor demand for mortgage banks’ products, capping
price rises, he said.

The likelihood of a sudden 5 percentage point rate rise is
slim, according to the ministry. Only once in the past 150 years
have rates fluctuated more than that over a 12-month period, it
said. That improbability will limit the risk premium investors
will charge, said Soeren Holm, chief financial officer at
Copenhagen-based Nykredit Realkredit A/S, Europe’s largest
issuer of mortgage-backed covered bonds.

Nykredit estimates “the extra price that will result from
this extra feature will be under 5 basis points,” Holm said by
phone. “We get a good solution that’s cheap.”